[Federal Register Volume 84, Number 206 (Thursday, October 24, 2019)]
[Notices]
[Pages 57089-57094]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-21515]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87110]


Order Granting a Conditional Exemption From Exchange Act Section 
11(D)(1) and Exchange Act Rules 10B-10, 15C1-5, 15C1-6, and 14E-5 for 
Certain Exchange Traded Funds

AGENCY: Securities and Exchange Commission.

ACTION: Exemptive order.

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SUMMARY: The Securities and Exchange Commission (``Commission'' or 
``SEC'') is issuing an order granting an exemption from compliance with 
certain provisions of the Securities Exchange Act of 1934 (``Exchange 
Act'') and the rules thereunder to broker-dealers and certain other 
persons engaging in certain transactions in securities of exchange-
traded funds (``ETFs'') relying on rule 6c-11 under the Investment 
Company Act of 1940 (``Investment Company Act'').

DATES: This exemptive order is effective December 23, 2019.

FOR FURTHER INFORMATION CONTACT: Darren Vieira, Special Counsel, 
Brandon Hill, Special Counsel, or Joanne Rutkowski, Assistant Chief 
Counsel, at (202) 551-5550; in the Division of Trading and Markets; 
Daniel Duchovny, Special Counsel, Office of Mergers and Acquisitions, 
at (202) 551-3440, in the Division of Corporation Finance; Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

    The Commission adopted rule 6c-11 under the Investment Company Act, 
which permits ETFs that satisfy certain conditions to operate without 
the expense and delay of obtaining an exemptive order from the 
Commission under the Investment Company Act.\1\ Rule 6c-11 is designed 
to create a consistent, transparent, and efficient regulatory framework 
for ETFs and to facilitate greater competition and innovation among 
ETFs.
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    \1\ Exchange Traded Funds, Investment Company Act Release No. 
33646 (Sep. 25, 2019) (``Rule 6c-11 Adopting Release'').
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    While the relief under rule 6c-11 is limited to exemptions under 
the Investment Company Act,\2\ commenters on proposed rule 6c-11 also 
recommended that the Commission harmonize with rule 6c-11 certain 
Exchange Act relief that ETFs currently rely on in order to operate, 
including relief from section 11(d)(l) of the Exchange Act and Exchange 
Act rules 10b-10, 15c1-5, 15c1-6, and 14e-5.\3\ Commenters expressed 
concern that the conditions that have been associated with Exchange Act 
relief are duplicative or, in some cases, inconsistent with other 
requirements applicable to ETFs.\4\
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    \2\ In the Rule 6c-11 Adopting Release, the Commission also 
provided an interpretation of certain other Exchange Act rules 
containing exemptions for transactions in redeemable securities 
issued by open-end companies and unit investment trusts as follows:
    After considering comments, we believe that it is appropriate to 
make all ETFs, including those that do not rely on rule 6c-11, 
eligible for the redeemable securities exceptions in rules 101(c)(4) 
and 102(d)(4) of Regulation M and rule 10b-17(c) under the Exchange 
Act in connection with secondary market transactions in ETF shares 
and the creation or redemption of creation units and the exemption 
in rule 11d1-2 under the Exchange Act for a registered open-end 
investment company or unit investment trust.
    \3\ See Comment Letter of Blackrock, Inc. at 21 (Sept. 26, 2018) 
(``BlackRock Comment Letter''); Comment Letter of the Investment 
Company Institute at 32 (Sept. 21, 2018) (``ICI Comment Letter''); 
Comment Letter of Fidelity Management & Research Company at 12 
(Sept. 28, 2018); Comment Letter of Dechert LLP at 8 (Sept. 28, 
2018) (``Dechert Comment Letter''); Comment Letter of the Securities 
Industry and Financial Markets Association--Asset Management Group 
at 22 and 23 (Sept. 28, 2018) (``SIFMA AMG Comment Letter''); 
Comment Letter of Vanguard at 2 (Sept. 28, 2018); Comment Letter of 
WisdomTree Asset Management at 2 (Oct. 1, 2018); Comment Letter of 
the American Bar Association at 4 (Oct. 11, 2018); Comment Letter of 
John Hancock Investments at 5 (Oct. 1, 2018); and Comment Letter of 
Flow Traders US LLP at 2 (Oct. 1, 2018).
    \4\ See, e.g., BlackRock Comment Letter. See also, e.g., ICI 
Comment Letter (``Currently, ETFs often must satisfy multiple and 
sometimes conflicting requirements from different divisions within 
the SEC.''). Commenters also expressed concerns about delays in 
obtaining such additional relief. See, e.g., SIFMA AMG Comment 
Letter I.
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    The Commission agrees that such relief could further reduce 
regulatory complexity and administrative delay, and eliminate potential 
inconsistencies between rule 6c-11 and the related Exchange Act relief 
that ETFs have obtained to operate.\5\ The Commission has considered 
the issues raised and believes that it is appropriate to grant relief 
from section 11(d)(1) and rules 10b-10, 15c1-5, 15c1-6, and 14e-5 
because broker-dealers and certain other persons that engage in these 
transactions and satisfy the conditions below, as applicable, would not 
raise the issues or concerns that underlie those provisions. 
Accordingly, the Commission finds that it is necessary and appropriate 
in the public interest and consistent with the protection of investors 
to grant an exemption from section 11(d)(1) of the Exchange Act and 
Exchange Act rules 10b-10, 15c1-5, 15c1-6, and 14e-5,to broker-dealers 
and certain other persons, as applicable, that engage in certain 
transactions with ETFs relying on rule 6c-11, subject to the conditions 
below.
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    \5\ Although the exemption granted by this order applies only to 
transactions in securities of ETFs that meet certain requirements 
and conditions, the beneficiaries of the relief, other than the 
relief under Exchange Act rule 14e-5, are broker-dealers that engage 
in transactions subject to the relevant provisions of the Exchange 
Act and rules thereunder. The beneficiaries of the relief under 
Exchange Act rule 14e-5 are ETFs, the legal entity of which the ETF 
is a series, and authorized participants, as described below.
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II. Background

    An ETF issues shares that can be bought or sold throughout the day 
in the secondary market at a market-determined price. Like other 
investment companies, an ETF pools the assets of multiple investors and 
invests those assets according to its investment objective and 
principal investment strategies. Each share of an ETF represents an 
undivided interest in the underlying assets of the ETF. Similar to 
mutual funds, ETFs continuously offer their shares for sale.
    Unlike mutual funds, however, ETFs do not sell or redeem individual 
shares. Instead, ``authorized participants'' that have contractual 
arrangements with the ETF, or one of its service providers, purchase 
and redeem ETF shares directly from the ETF in blocks called ``creation 
units.'' \6\ An authorized participant may act as a principal for its 
own account when purchasing or redeeming creation units from the ETF. 
Authorized participants also may act as agent for others, such as 
market makers, proprietary trading firms, hedge funds or other 
institutional investors, and receive fees for processing creation units

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on their behalf.\7\ Market makers, proprietary trading firms, and hedge 
funds provide additional liquidity to the ETF market through their 
trading activity. Institutional investors may engage in primary market 
transactions with an ETF through an authorized participant as a way to 
efficiently hedge a portion of their portfolio or balance sheet or to 
gain exposure to a strategy or asset class.\8\ Redemptions from ETFs 
are often made in kind (that is, by delivering certain assets from the 
ETF's portfolio), rather than in cash, thereby avoiding the need for 
the ETF to sell assets and potentially realize capital gains that are 
distributed to its shareholders. Similarly, ETF creations may be made 
in kind by delivering certain assets to the ETF's portfolio, rather 
than solely delivering cash.
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    \6\ Rule 6c-11(a)(1) defines ``authorized participant'' as a 
member or participant of a clearing agency registered with the 
Commission, which has a written agreement with the ETF or one of its 
service providers that allows the authorized participant to place 
orders for the purchase and redemption of creation units. See Rule 
6c-11 Adopting Release.
    \7\ See David J. Abner, The ETF Handbook: How to Value and Trade 
Exchange Traded Funds, 2nd ed. (2016).
    \8\ Id.
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    An authorized participant that purchases a creation unit of ETF 
shares directly from the ETF deposits with the ETF a ``basket'' of 
securities and other assets identified by the ETF that day, and then 
receives the creation unit of ETF shares in return for those assets.\9\ 
The basket is generally representative of the ETF's portfolio,\10\ and 
together with a cash balancing amount, it is equal in value to the 
aggregate net asset value (``NAV'') of the ETF shares in the creation 
unit.\11\ After purchasing a creation unit, the authorized participant 
may hold the individual ETF shares, or sell some or all of them in 
secondary market transactions.\12\ Investors then purchase individual 
ETF shares in the secondary market.
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    \9\ An ETF may impose fees in connection with the purchase or 
redemption of creation units that are intended to defray operational 
processing and brokerage costs to prevent possible shareholder 
dilution (``transaction fees'').
    \10\ The basket might not reflect a pro rata slice of an ETF's 
portfolio holdings. Subject to the terms of the applicable exemptive 
relief, an ETF may substitute other securities or cash in the basket 
for some (or all) of the ETF's portfolio holdings. Conditions 
related to flexibility in baskets have varied over time. See Rule 
6c-11 Adopting Release, at section II.C.5.
    \11\ An open-end fund is required by law to redeem its 
securities on demand from shareholders at a price approximating 
their proportionate share of the fund's NAV at the time of 
redemption. See 15 U.S.C. 80a-22(d). 17 CFR 270.22c-1 (``rule 22c-
1'') generally requires that funds calculate their NAV per share at 
least once daily Monday through Friday. See rule 22c-1(b)(1). Today, 
most funds calculate NAV per share as of the time the major U.S. 
stock exchanges close (typically at 4:00 p.m. Eastern Time). Under 
rule 22c-1, an investor who submits an order before the 4:00 p.m. 
pricing time receives that day's price, and an investor who submits 
an order after the pricing time receives the next day's price. See 
also 17 CFR 270.2a-4 (``rule 2a-4'') (defining ``current net asset 
value'').
    \12\ ETFs register offerings of shares under the Securities Act 
of 1933 (the ``Securities Act''), and list their shares for trading 
under the Exchange Act. Depending on the facts and circumstances, 
authorized participants that purchase a creation unit and sell the 
shares may be deemed to be participants in a distribution, which 
could render them statutory underwriters and subject them to the 
prospectus delivery and liability provisions of the Securities Act. 
See 15 U.S.C. 77b(a)(11) (defining the term ``underwriter'').
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    By this order, the Commission is seeking to reduce the complexities 
and burden that may otherwise be associated with the ETF creation and 
redemption process, subject to appropriate conditions intended to 
ensure investor protections.

III. Discussion of the Exemption

    The Commission is granting a conditional exemption from Exchange 
Act section 11(d)(1) and Exchange Act rules 10b-10, 15c1-5, 15c1-6, and 
14e-5 as discussed further below. The exemption should help to simplify 
the offering and operating process for ETFs. The exemption will provide 
relief to broker-dealers from these provisions of the Exchange Act with 
respect to ETFs relying on rule 6c-11.\13\ In order for a broker-dealer 
to rely on the relief, other than the relief from rule 14e-5, a 
transaction must involve an ETF that further satisfies the 
diversification requirement below. In addition, a broker-dealer relying 
on this relief must meet certain conditions specific to each applicable 
Exchange Act provision or rule. Finally, except as provided in Sections 
III.E.2 and III.F below, this relief does not apply to purchases or 
sales of ETF shares in the secondary market.\14\
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    \13\ Going forward, this exemptive order will provide exemptive 
relief from section 11(d)(1) and rules 10b-10, 15c1-5, 15c1-6, and 
14e-5 in connection with transactions in securities issued by newly 
formed ETFs that rely on rule 6c-11. Commission staff will continue 
to consider requests with respect to the relevant Exchange Act 
provisions in connection with transactions in securities issued by 
newly formed ETFs that do not rely on rule 6c-11 or otherwise do not 
satisfy the conditions of this exemption.
    \14\ As discussed below, this order provides an exemption from 
section 11(d)(1) for a Non-AP Broker-Dealer (defined below) that 
transacts in shares of an ETF that relies on rule 6c-11, exclusively 
in the secondary market, when it extends or maintains or arranges 
for the extension or maintenance of credit to or for customers on 
such ETF shares. This order also provides an exemption that allows 
certain specified ``covered persons'' with respect to a tender offer 
to engage in creation and redemption transactions with an ETF that 
relies on rule 6c-11 subject to certain conditions described below.
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    The Commission is limiting relief under this exemption to 
transactions in securities issued by ETFs that rely on rule 6c-11 
because the specific findings in support of the exemptive order are 
based, in part, on the conditions in rule 6c-11. The Commission 
believes that the portfolio and other transparency requirements in rule 
6c-11, when combined with the conditions in this order, address the 
policy concerns underlying the relevant statutory provision and rules. 
For example, rule 6c-11 requires ETFs to disclose their portfolio 
holdings each day through their website. This portfolio transparency, 
along with the availability of information regarding ETFs through the 
National Securities Clearing Corporation (``NSCC''), other 
intermediaries, and the ETF itself, should provide customers engaging 
in creation or redemption transactions an opportunity to identify or 
inquire about potential conflicts of interest involving a component 
security a broker-dealer would otherwise be required to disclose. These 
requirements should also help customers determine if they should 
request that their broker-dealer provide any omitted information.

A. Reliance on Rule 6c-11

    The exemption from Exchange Act section 11(d)(1) and Exchange Act 
rules 10b-10, 15c1-5, 15c1-6, and 14e-5 is only available with respect 
to transactions involving securities of an ETF relying on rule 6c-11. 
The rule defines an ETF as a registered open-end management investment 
company that: (i) Issues (and redeems) creation units to (and from) 
authorized participants in exchange for a basket and a cash balancing 
amount (if any); and (ii) issues shares that are listed on a national 
securities exchange and traded at market-determined prices.\15\ Among 
the requirements to rely on rule 6c-11 are:
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    \15\ Rule 6c-11(a)(1). Under the rule, the term ``basket'' means 
the securities, assets, or other positions in exchange for which an 
ETF issues (or in return for which it redeems) creation units. See 
id. ETFs will therefore transact on an in-kind basis, on a cash 
basis, or both.
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    1. The ETF is structured as an open-end management investment 
company;
    2. The ETF discloses portfolio holdings each business day on its 
website before the opening of regular trading on the primary listing 
exchange of the ETF's shares in a standardized manner;
    3. The ETF provides website disclosure of (i) the ETF's current NAV 
per share, market price, and premium or discount, each as of the end of 
the prior business day; (ii) a table showing the number of days the 
ETF's shares traded at a premium or discount during the most recently 
completed calendar year and calendar quarters of the current year; 
(iii) a line graph showing ETF premiums and discounts for the most 
recently completed year and calendar

[[Page 57091]]

quarter of the current year; (iv) for ETFs whose premium or discount 
was greater than two percent for more than seven consecutive trading 
days, disclosure of this premium or discount, along with a discussion 
of the factors that are reasonably believed to have materially 
contributed to the premium or discount; and (iv) the ETF's median bid-
ask spread over the most recent thirty calendar days;
    4. The ETF adopts and implement written policies and procedures 
that govern the construction of baskets and the process that will be 
used for the acceptance of baskets. If the ETF utilizes custom baskets, 
these policies and procedures must (i) set forth detailed parameters 
for the construction and acceptance of custom baskets that are in the 
best interest of the ETF and its shareholders, including the process 
for any revisions to, or deviations from, those parameters; and (ii) 
specify the titles or roles of the employees of the ETF's investment 
adviser who are required to review each custom basket for compliance 
with those parameters; and
    5. The ETF preserves and maintains copies of all written agreements 
between an authorized participant and the ETF (or one of the ETF's 
service providers) that allow the authorized participant to purchase or 
redeem creation units.
    Consistent with our approach in Rule 6c-11, the exemption provided 
by this order will be available regardless of whether the ETF is 
actively managed \16\ and without regard to the number of ETF shares in 
the ETF's creation or redemption baskets or the value of those creation 
and redemption baskets.\17\
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    \16\ Rule 6c-11 Adopting Release, sec. II.A.2.
    \17\ Id. at sec. II.C.1.
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B. Minimum Diversification Requirement

    The exemption provided by this order from Exchange Act section 
11(d)(1) and Exchange Act rules 10b-10, 15c1-5, and 15c1-6 is available 
only with respect to transactions involving an ETF that meets the 
diversification requirement applicable to a regulated investment 
company in Internal Revenue Code (``IRC'') Sec. 851(b)(3)(B), 26 U.S.C. 
851(b)(3)(B) (the ``IRC diversification requirement'').\18\ 
Diversification is a consideration with respect to each requirement 
from which the Commission is granting exemption in this order, except 
for rule 14e-5. Creation and redemption transactions in diversified 
ETFs involve the exchange of a basket that contains numerous 
securities, which in turn implicates disclosure requirements, as 
discussed below, under rules 10b-10, 15c1-5, and 15c1-6. At the same 
time, the composite nature of a diversified basket means that the 
securities of any one issuer will account for a relatively small share 
of the basket. Diversification thus should mitigate any conflicts that 
a broker-dealer would otherwise be required to disclose under rules 
15c1-5 and 15c-6, and minimize the incentive for a broker-dealer to 
seek to use an ETF to evade the new issue lending restriction in 
Exchange Act section 11(d)(1).\19\
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    \18\ IRC Section 851(b)(3)(B) provides that a ``regulated 
investment company'' must have:
    not more than 25 percent of the value of its total assets is 
invested in--(i) the securities (other than Government securities or 
the securities of other regulated investment companies) of any one 
issuer, (ii) the securities (other than the securities of other 
regulated investment companies) of two or more issuers which the 
taxpayer controls and which are determined, under regulations 
prescribed by the Secretary [of the Treasury], to be engaged in the 
same or similar trades or businesses or related trades or 
businesses, or (iii) the securities of one or more qualified 
publicly traded partnerships (as defined in subsection (h)).
    \19\ A commenter on proposed Rule 6c-11 also noted that ETFs 
generally must comply with the IRC diversification requirement, 
which imposes a practical limit on the concentration of an ETF's 
portfolio. Dechert Comment Letter at 12-13. The commenter stated 
that it would be impractical and inefficient for a broker-dealer to 
utilize an ETF as a mechanism for distribution of a particular 
security or for accumulating substantial positions in one or more of 
an ETF's underlying securities in a magnitude that would trigger 
disclosure. Id.
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    Diversification, together with the conditions discussed below, 
forms the basis for the Commission's conclusion that relief from 
section 11(d)(1) and rules 10b-10, 15c1-5, and 15c1-6 is necessary and 
appropriate in the public interest and consistent with investor 
protection.

C. Exemption From Exchange Act Rule 10b-10

    Exchange Act rule 10b-10 generally requires a broker or dealer that 
effects a securities transaction for a customer to send to the 
customer, at or before the completion of the transaction, a written 
notification (``confirmation'') disclosing certain information, 
including among other items, the identity, price, and number of share 
or units (or principal amount) of the security purchased or sold by the 
customer. The confirmation requirement provides basic investor 
protections by conveying information that allows investors to verify 
the terms of their transactions; alerting investors to potential 
conflicts of interest with their broker-dealers; acting as a safeguard 
against fraud; and providing investors a means to evaluate the costs of 
their transactions and the quality of their broker-dealer's 
execution.\20\ When an authorized participant that is a registered 
broker-dealer (``Broker-Dealer AP'') engages in creation and redemption 
transactions for its customers, each tender or receipt of a component 
security as part of a basket is a purchase \21\ or sale \22\ of a 
security, and each purchase or sale requires confirmation pursuant to 
Exchange Act rule 10b-10.
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    \20\ Exchange Act Release No. 34962 (November 10, 1994), 59 FR 
59612, 59613 (November 17, 1994).
    \21\ Exchange Act Sec. 3(a)(13).
    \22\ Exchange Act Sec. 3(a)(14).
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    The Commission is granting an exemption from Exchange Act rule 10b-
10 that will allow a broker-dealer that is effecting an in-kind 
creation or redemption transaction on behalf of a customer to confirm 
the transaction without providing a contemporaneous statement of the 
identity, price or number of shares or units (or principal amount) of 
each component security tendered to or delivered by the ETF, subject to 
the following conditions:
    1. Confirmation statements of issuance and redemption transactions 
in ETF shares will contain all of the information specified in 
paragraph (a) of rule 10b-10 other than identity, price, and number of 
shares or units (or principal amount) of each component security 
tendered or received by the customer in the transaction.
    2. Any confirmation statement of an issuance or redemption 
transaction in ETF shares that omits the identity, price, or number of 
shares or units (or principal amount) of component securities will 
contain a statement that such omitted information will be provided to 
the customer upon request; and
    3. All such requests will be fulfilled in a timely manner in 
accordance with paragraph (c) of rule 10b-10.
    The requirement that confirmation statements include all of the 
information specified in paragraph (a) of rule 10b-10 other than the 
identity, price, and number of shares or units (or principal amount) of 
each component security tendered or received in the transaction 
preserves a customer's right to receive other important information 
from the confirmation about the terms of the customer's transaction at 
or before the completion of the transaction. The statement that the 
omitted information will be provided upon request informs the customer 
of the right to receive the omitted information. The requirement for a 
broker-dealer to fulfill such requests in a timely manner in accordance 
with paragraph (c) of rule 10b-10 clarifies that a broker-dealer

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must fulfill the request within a prescribed period (i.e., within five 
business days of receipt of the request, or within 15 business days of 
a request pertaining to a transaction effected more than 30 days prior 
to the receipt of the request) so that customers can be assured that 
they receive the requested information in a timely manner.
    The Commission also believes that, in general, information 
regarding ETFs is accessible through a variety of sources, including 
the NSCC, intermediaries and the ETFs themselves. The Commission 
believes that the conditions above will allow any customers who would 
like additional information regarding identity, price, or number of 
shares or units (or principal amount) to receive the information in a 
timely manner. This exemption reduces the burden that may otherwise be 
associated with creation and redemption transactions while preserving a 
customer's ability to access the omitted information upon request.

D. Exemption From Exchange Act Rules 15c1-5 and 15c1-6

    Exchange Act rule 15c1-5 requires a broker-dealer effecting a 
transaction to disclose any control relationship with an issuer of a 
security that it purchases for or sells to a customer. Similarly, Rule 
15c1-6 requires a broker-dealer to disclose its participation or 
interest in a primary or secondary distribution of a security that it 
purchases for or sells to a customer. The Commission is granting a 
conditional exemption from Exchange Act rules 15c1-5 and 15c1-6 that 
will allow a broker-dealer that is effecting an in-kind creation or 
redemption transaction on behalf of a customer to effect that 
transaction without providing disclosure regarding a control 
relationship with an issuer or participation in a distribution of a 
component security tendered to or delivered by the ETF.
    As discussed above, the composite nature of diversified ETF 
portfolios and the relatively small proportionate share of any 
component security in a basket mean that any individual ETF portfolio 
security that would be subject to disclosure under rules 15c1-5 or 
15c1-6 will be a small portion of the portfolio. This diversification 
should reduce the impact that any potential conflicts of interest 
involving a component security that a broker-dealer may have and 
mitigate the concern that a broker-dealer could use an ETF to avoid 
disclosure of a conflict of interest that would otherwise be required 
to be disclosed under rules 15c1-5 and 15c-6.
    Rule 6c-11 provides ETFs with flexibility to use custom baskets 
that contain a non-representative selection of the ETFs' portfolio 
securities.\23\ To the extent the contents of custom creation or 
redemption baskets are negotiated between an authorized participant and 
the ETF, the customer, via the authorized participant, should have 
visibility into the contents of the basket. This visibility should 
provide a customer seeking to engage in creation or redemption 
transactions an opportunity to identify or otherwise inquire about 
control relationships with the issuer or interest in a distribution of 
a component security that a broker-dealer would otherwise be required 
to disclose pursuant to these rules.
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    \23\ If different baskets are used in transactions on the same 
business day, each basket after the initial representative basket 
would constitute a custom basket. See Rule 6c-11 Adopting Release, 
sec. II.C.5.
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    The exemption from rules 15c1-5 and 15c1-6 is subject to a further 
condition that requires the broker-dealer to provide any information to 
which a customer is entitled under rule 15c1-5 or 15c1-6 upon request 
and to fulfill such requests in a timely manner. The Commission 
believes that this condition will ensure that any customers who would 
like to access this information for any of the investor protections 
needs described above will be able to receive it.
    Similar to rule 10b-10 above, the Commission believes that the 
general availability of information regarding ETFs through a variety of 
sources, including the NSCC, intermediaries and the ETFs themselves, 
supports this exemption. This access allows market participants that 
use basket information to obtain information regarding securities they 
will exchange in a creation or redemption transaction. The Commission 
believes that this information also should provide market participants 
seeking to engage in creation or redemption transactions an opportunity 
to identify or otherwise inquire about the control relationships or 
interest in a distribution that a broker-dealer would otherwise be 
required to disclose pursuant to these rules.

E. Exemption From Section 11(d)(1)

    Exchange Act section 11(d)(1) generally prohibits a person that is 
both a broker and a dealer from extending or maintaining credit, or 
arranging for the extension or maintenance of credit, to or for a 
customer on any security (other than an exempted security) which was 
part of a distribution of a new issue of securities in which the 
broker-dealer participated. Because ETFs are in continuous 
distribution, broker-dealers effecting creation and redemption 
transactions on behalf of customers are participating in the 
distribution of new issue securities with respect to shares of ETFs, 
and thus are continuously subject to the restrictions of section 
11(d)(1). Section 11(d)(1) issues arise both with Broker-Dealer APs and 
with broker-dealers who effect only secondary market transactions 
(``Non-AP Broker-Dealers'').
1. Conditions for Broker-Dealer Authorized Participants
    As noted in section II above, a Broker-Dealer AP is a registered 
broker-dealer that has entered into a contractual arrangement with an 
ETF or one of its service providers that allows the Broker-Dealer AP to 
place orders for the purchase or redemption of creation units, but 
Broker-Dealer APs are not compensated by ETFs in connection with the 
creation or redemption of ETF shares. Broker-Dealers may have different 
reasons for becoming authorized participants, including for their own 
proprietary trading, to facilitate customer trades, to hedge or 
otherwise manage their own risk, or to arbitrage differences between 
the ETF's market price and its NAV.
    The Commission is granting an exemption from the new issue lending 
restriction in section 11(d)(1) for a Broker-Dealer AP that extends or 
maintains credit, or arranges for the extension or maintenance of 
credit, on ETF shares subject to the following two conditions:
    1. Neither the Broker-Dealer AP, nor any natural person associated 
with such Broker-Dealer AP, directly or indirectly (including through 
any affiliate of such Broker-Dealer AP), receives from the ``Fund 
Complex'' \24\ any payment, compensation, or other economic incentive 
to promote or sell the shares of the ETF to persons outside the fund 
complex, other than non-cash compensation currently permitted under 
Financial Industry and Regulatory Authority (``FINRA'') rule 
2341(l)(5)(A), (B), or (C) (``non-cash compensation'').\25\
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    \24\ For purposes of this order, a ``Fund Complex'' is the 
issuer of the ETF shares, any other issuer of ETF shares that holds 
itself out to investors as a related company for purposes of 
investment or investor services; any investment adviser, 
distributor, sponsor, or depositor of any such issuer; or any 
``affiliated person'' (as defined in the Investment Company Act 
section 2(a)(3)) of any such issuer or any such investment adviser, 
distributor, sponsor, or depositor.
    \25\ Non-cash compensation currently permitted under FINRA rule 
2341(l)(5)(A), (B), or (C) is limited to:
    (A) Gifts that do not exceed an annual amount per person fixed 
periodically by FINRA and are not preconditioned on achievement of a 
sales target;
    (B) An occasional meal, a ticket to a sporting event or the 
theater, or comparable entertainment which is neither so frequent 
nor so extensive as to raise any question of propriety and is not 
preconditioned on achievement of a sales target; [and]
    (C) Payment or reimbursement by offerors in connection with 
meetings held by an offeror or by a member for the purpose of 
training or education of associated persons of a member, subject to 
certain conditions.

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    2. The Broker-Dealer AP does not extend, maintain or arrange for 
the extension or maintenance of credit to or for a customer on shares 
of the ETF before thirty days have passed from the date that the ETF's 
shares initially commence trading (except to the extent that such 
extension, maintenance, or arranging of credit is otherwise permitted 
pursuant to rule 11d1-1).
    The exemption permits a Broker-Dealer AP to accept only limited 
forms of non-cash compensation that do not present broker-dealers with 
the types of potential conflicts of interest in their sale of 
securities that section 11(d)(1) addresses.\26\ This absence of any 
special compensation to distribute shares mitigates the potential 
conflicts of interest that section 11(d)(1) addresses. In addition, 
requiring a Broker-Dealer AP to wait thirty days before margining its 
customers' ETF shares is consistent with the section 11(d)(1) 
prohibition against a broker-dealer extending credit on securities that 
were part of a new issue, if the broker-dealer participated in the 
distribution of the new issue securities within the preceding thirty 
days. Thus, this condition ensures that Broker-Dealer APs do not use 
credit to induce customers to buy ETF shares for at least a 30-day 
period following launch of the ETF, similar to the prohibition against 
extending credit that applies to other types of new issue securities 
under section 11(d)(1).
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    \26\ See Exchange Act Release No. 21557 (Dec. 18, 1984), 49 FR 
50172 at 50173-74 (Dec. 27, 1984) (available at: https://cdn.loc.gov/service/ll/fedreg/fr049/fr049250/fr049250.pdf).
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2. Conditions for Non-AP Broker-Dealers
    Many broker-dealers effect ETF securities transactions solely on 
the secondary market, whether for themselves or as agent for their 
customers. They do not enter contractual arrangements to effect 
creation or redemption transactions with the ETF or one of its service 
providers. Thus, these Non-AP Broker-Dealers have not undertaken to 
distribute ETF shares and generally do not receive any compensation for 
selling ETF shares, other than, in some cases, limited forms of non-
cash compensation. Non-AP Broker-Dealers may reasonably be considered 
not to be participating in the distribution of new issue securities 
within the meaning of section 11(d)(1). However, to remove any 
ambiguity about the circumstances when Non-AP Broker-Dealers may offer 
margin on ETF securities the Commission is granting this exemption from 
section 11(d)(1).
    The Commission believes this relief is appropriate because, as 
stated above, Non-AP Broker-Dealers do not engage in creation and 
redemption transactions with ETFs and, thus, may reasonably be 
considered not to be participating in the distribution of the ETFs' 
securities. In addition, this relief is subject to the condition that 
Non-AP Broker-Dealers do not (and their associated persons who are 
natural persons do not), directly or indirectly (including through any 
affiliate of such Non-AP Broker-Dealer), receive from the Fund Complex 
any payment, compensation or other economic incentive to promote or 
sell the shares of the ETF to persons outside the Fund Complex, other 
than non-cash compensation. For the foregoing reasons, the Commission 
believes it is necessary and appropriate and in the public interest and 
consistent with investor protection to grant this exemption.

F. Exemption From Rule 14e-5

    Exchange Act rule 14e-5 prohibits ``covered persons'' from directly 
or indirectly purchasing or arranging to purchase any securities that 
are the subject of a tender offer (``subject securities'') \27\ or any 
securities that are immediately convertible into, exchangeable for, or 
exercisable for subject securities (``related securities'') \28\ except 
as part of such tender offer. The term ``covered person'' includes, 
among others, a dealer-manager of a tender offer and any person acting, 
directly or indirectly, in concert with other covered persons in 
connection with any purchase or arrangement to purchase any subject 
securities or any related securities.\29\ Therefore, the prohibitions 
of rule 14e-5 may apply to authorized participants who are broker-
dealers and acting as dealer-managers in tender offers, the ETF, and 
any legal entity of which the ETF is a series.
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    \27\ Exchange Act rule 14e-5(c)(7).
    \28\ Exchange Act rule 14e-5(c)(6).
    \29\ Exchange Act rule 14e-5(c)(3).
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    The Commission is granting a conditional exemption from rule 14e-5 
to an ETF, the legal entity of which the ETF is a series, and 
authorized participants and any other persons who create and redeem 
shares of the ETF in creation units pursuant to contractual 
arrangements pertaining to such legal entity and the ETF, and who are 
covered persons with respect to a tender offer involving an ETF's 
component securities. The conditional exemption will allow such persons 
(i) to redeem ETF shares in creation unit sizes for a redemption basket 
that may include a subject security or related security, (ii) to engage 
in secondary market transactions with respect to the ETF shares after 
the first public announcement of the tender offer and during such 
tender offer given that such transactions could include, or be deemed 
to include, purchases of, or arrangements to purchase, subject 
securities or related securities, and (iii) make purchases of, or 
arrangements to purchase, subject securities or related securities in 
the secondary market for the purpose of transferring such securities to 
purchase one or more creation units of ETF shares. The exemption from 
rule 14e-5 is subject to the following conditions:
    1. No purchases of subject securities or related securities made by 
broker-dealers acting as dealer-managers of a tender offer would be 
effected for the purpose of facilitating a tender offer;
    2. If there is a change in the composition of a ETF's portfolio of 
component securities and a broker-dealer acting as a dealer-manager of 
a tender offer is unable to rely on the exception found in rule 14e-
5(b)(5) for basket transactions because (i) the basket of subject 
securities or related securities contains fewer than 20 securities or 
(ii) the subject securities and related securities make up more than 5% 
of the value of the basket, then any purchases of an ETF component 
security by such dealer-manager during a tender offer will be effected 
for the purpose of adjusting a basket of securities in the ordinary 
course of its business and not for the purpose of facilitating a tender 
offer; and
    3. Except for the relief specifically granted herein, any broker-
dealer acting as a dealer-manager of a tender offer will comply with 
rule 14e-5.
    The Commission believes this exemption will facilitate the ability 
of authorized participants and others to engage in creation or 
redemption transactions between the public announcement of a tender 
offer and its expiration, thereby permitting the ETF to operate as 
intended for the benefit of its holders and as disclosed in publicly 
filed documents. The conditions applicable to the relief will ensure 
that authorized participants and other recipients of the relief do not 
effect creation or redemption transactions

[[Page 57094]]

during the relevant tender offer period in an effort to facilitate the 
tender offer. For the foregoing reasons, the Commission believes it is 
necessary and appropriate and in the public interest and consistent 
with investor protection to grant this exemption.

IV. Conclusion

    In light of the above, and in accordance with Exchange Act Section 
36, the Commission finds that conditionally exempting broker-dealers 
that engage in certain transactions in securities of ETFs that can rely 
on Investment Company Act rule 6c-11 from the requirements of section 
11(d)(1) of the Exchange Act and Exchange Act rules 10b-10, 15c1-5, 
15c1-6, and 14e-5 necessary and appropriate in the public interest, and 
consistent with the protection of investors.
    Therefore, it is hereby ordered, pursuant to section 36 of the 
Exchange Act, subject to the conditions described in Sections III.A, B, 
and C above, that a broker or dealer is exempt from Exchange Act rule 
10b-10 with respect to creation or redemption transactions on behalf of 
customers in securities issued by ETFs relying on Investment Company 
Act rule 6c-11.
    It is further ordered, pursuant to section 36 of the Exchange Act, 
subject to the conditions described in Sections III.A, B, and D above, 
that a broker or dealer is exempt from Exchange Act rule 15c1-5 with 
respect to creation or redemption transactions on behalf of customers 
in securities issued by ETFs relying on Investment Company Act rule 6c-
11.
    It is further ordered, pursuant to section 36 of the Exchange Act, 
subject to the conditions described in Sections III.A, B, and D above, 
that a broker or dealer is exempt from Exchange Act rule 15c1-6 with 
respect to creation or redemption transactions on behalf of customers 
in securities issued by ETFs relying on Investment Company Act rule 6c-
11.
    It is further ordered, pursuant to section 36 of the Exchange Act, 
subject to the conditions described in Sections III.A, B, and E.1. 
above, that an AP Broker-Dealer in a particular ETF relying on 
Investment Company Act rule 6c-11 is exempt from section 11(d)(1) of 
the Exchange Act with respect to the extension or maintenance of 
credit, or the arranging of the extension or maintenance of credit, on 
securities issued by such ETF.
    It is further ordered, pursuant to section 36 of the Exchange Act, 
subject to the conditions described in Section III.A, B, and E.2 above, 
that a Non-AP Broker-Dealer that effects transactions in shares of an 
ETF relying on Investment Company Act rule 6c-11, exclusively in the 
secondary market, is exempt from section 11(d)(1) when it extends or 
maintains, or arranges for the extension or maintenance of credit to or 
for customers on such ETF shares.
    It is further ordered, pursuant to section 36 of the Exchange Act, 
subject to the conditions described in Sections III.A and F above, the 
ETF and other persons described in Section III.F are exempt from 
Exchange Act rule 14e-5 with respect to the transactions described in 
Section III.F above.
    This exemption is subject to modification or revocation at any time 
the Commission determines that such action is necessary or appropriate 
in furtherance of the purposes of the Exchange Act. In addition, 
persons relying on this exemption are directed to the anti-fraud and 
anti-manipulation provisions of the federal securities laws, 
particularly section 10(b) of the Exchange Act and rule 10b-5 
thereunder.

    By the Commission.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2019-21515 Filed 10-23-19; 8:45 am]
BILLING CODE 8011-01-P


